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IRS doubles down on capital treatment for merger termination fee

TAX BLOG
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November 07, 2016

In the recently issued Chief Counsel Advice, CCA 201642035, the IRS doubled down on its section 1234A position, stating that a merger termination fee received by a taxpayer was a capital transaction and gain or loss was determined based upon the difference between the termination fee received and the costs previously capitalized related to the transaction. The position in the CCA may be contrary to regulations under section 263 that would support an ordinary section 165 loss on the write off of previously capitalized fees.

The transaction in question related to receipt of a termination fee by a potential acquirer. The contract included a termination fee from the target of $1 million payable to the acquirer should the deal be terminated. The target received a superior offered and paid the termination fee of $1 million to the acquirer. The taxpayer requested the IRS provided clarity on how the gain [from the receipt of the termination fee] should be calculated.

In coming to this conclusion the IRS looked to section 1234A, which states the character of the gain on a lapse, termination or cancellation of a contract to acquire a capital asset is itself a capital asset. This memorandum follows the IRS previously released Field Attorney Advice FAA 20163701F which also characterized the termination fee as a capital item and cited section 1234A. In the previous case the IRS ruled on the treatment of the payor of a termination fee as opposed to the recipient (see, IRS rules payment of M&A breakup fee generated capital loss).

In summary, each of the two previous rulings have wide ranging impacts to termination fees paid or received. The IRS is focusing on fees paid subject to a contract, so a significant question may become whether termination fees are paid under a contract, and when a contract exists. For example, is a termination fee paid pursuant to a letter of intent a payment under a contract? We recommend discussing the tax treatment of any termination fee with your tax advisor.

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